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HAST > SEC Filings for HAST > Form 10-Q on 10-Jun-2014All Recent SEC Filings

Show all filings for HASTINGS ENTERTAINMENT INC

Form 10-Q for HASTINGS ENTERTAINMENT INC


10-Jun-2014

Quarterly Report


ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Forward-looking Statements

Certain written and oral statements set forth below or made by Hastings with the approval of an authorized executive officer constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The words "believe," "expect," "intend," "anticipate," "project," "will" and similar expressions identify forward-looking statements, which generally are not historical in nature. All statements that address operating performance, events or developments that we expect or anticipate will occur in the future including statements relating to the business, expansion, merchandising and marketing strategies of Hastings, industry projections or forecasts, inflation, effect of critical accounting policies including lower of cost or market for inventory adjustments, the returns process, rental asset depreciation, store closing reserves, impairment or disposal of long-lived assets, revenue recognition, and vendor allowances, sufficiency of cash flow from operations and borrowings under our revolving credit facility and statements expressing general opinions about future operating results are forward-looking statements. Such statements are based upon our management's current estimates, assumptions and expectations, which are based on information available at the time of the disclosure, and are subject to a number of factors and uncertainties, including, but not limited to, consumer appeal of our existing and planned product offerings, and the related impact of competitor pricing and product offerings; overall industry performance and the accuracy of our estimates and judgments regarding trends; our ability to obtain favorable terms from suppliers; the reduction or elimination of the in-store window for rental video; our ability to respond to changing consumer preferences, including with respect to new technologies and alternative methods of content delivery, and to effectively adjust our offerings if and as necessary; the application and impact of future accounting policies or interpretations of existing accounting policies; whether our assumptions turn out to be correct; our inability to attain such estimates and expectations; a downturn in market conditions in any industry relating to the products we inventory, sell or rent; the degree to which we enter into and maintain vendor relationships; the challenging times that the U.S. and global economies are currently experiencing, the effects of which have had and will continue to have an adverse impact on spending by Hastings' current retail customer base and potential new customers, and the possibility that general economic conditions could deteriorate further, volatility of fuel and utility costs; acts of war or terrorism inside the United States or abroad; unanticipated adverse litigation results or effects; the effect of inclement weather on the ability of consumers to reach our stores and other factors which may be outside of our control; any of which could cause actual results to differ materially from those described herein. We undertake no obligation to affirm, publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

The following discussion should be read in conjunction with the unaudited consolidated financial statements of the Company and the related notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.

General

Incorporated in 1972, Hastings Entertainment, Inc. (the "Company," "Hastings," or "Hastings Entertainment") is a leading multimedia entertainment and lifestyle retailer. We operate entertainment superstores that buy, sell, trade and rent various home entertainment products, including books, music, software, periodicals, movies on DVD and Blu-ray, video games, video game consoles, hobby, sports and recreation, lifestyle and consumer electronics. We also offer consumables and trends products such as apparel, t-shirts, action figures, posters, greeting cards and seasonal merchandise. As of April 30, 2014, we operated 126 superstores principally in medium-sized markets located in 19 states, primarily in the Western and Midwestern United States. We also operate three concept stores, Sun Adventure Sports, located in Amarillo, Texas and Lubbock, Texas, and TRADESMART, located in Littleton, Colorado. Sun Adventure Sports sells a wide range of bicycles and related accessories, skateboards, and various other athletic equipment, apparel, and shoes, and offers bicycle repair services and cycling classes. TRADESMART, born from the culture of recycling, features over 450,000 predominantly used and new books, CDs, DVDs, Blu-rays, video games and video game systems, as well as consumer electronics, trends, skateboards and paintball merchandise, and much more available for purchase. TRADESMART also buys back for cash or store credit entertainment products that customers have previously enjoyed.

We also operate a multimedia entertainment e-commerce web site offering a broad selection of books, software, video games, movies on DVD and Blu-ray, music, trends, comics, sports & recreation and electronics. We fill orders for new and used product placed at the website and also through Amazon and eBay Marketplaces using our proprietary goShip program, which allows us to ship directly from stores or the distribution center. We have one wholly-owned subsidiary; Hastings Internet, Inc. References herein to fiscal years


are to the twelve-month periods that end in January of each following calendar year. For example, the twelve-month period ending January 31, 2015 is referred to as fiscal 2014.

Merger Agreement

As described under the heading "Merger Agreement" in Item 1 of our Annual Report on Form 10-K, for the fiscal year ended January 31, 2014, on March 17, 2014, we entered into an Agreement and Plan of Merger(the "Merger Agreement") with Draw Another Circle, LLC ("Parent") and its wholly owned subsidiary. Pursuant to the Merger Agreement, subject to satisfaction or waiver of certain closing conditions, Merger Sub will merge with and into the Company, with the Company continuing its existence under Texas law as the surviving entity in the Merger. Upon the completion of the Merger, the Company will be a wholly owned subsidiary of Parent.

If the Merger is completed, at the effective time of the Merger, each share of common stock of the Company issued and outstanding as of immediately prior to the effective time (excluding any shares of common stock held by Parent or its affiliates , any shares of common stock held by the Company in treasury or by any direct or indirect wholly owned subsidiary of the Company) will be automatically cancelled and converted into the right to receive the merger consideration of $3.00 per share as provided in the Merger Agreement.

Critical Accounting Estimates

The preparation of the financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. We believe the following critical accounting estimates comprise our more significant estimates and assumptions used in the preparation of our financial statements. Our significant estimates and assumptions are reviewed, and any required adjustments are recorded, on a monthly or quarterly basis.

Lower of Cost or Market for Merchandise Inventory. Our merchandise inventories are recorded at the lower of cost, which approximates the first-in, first-out ("FIFO") method, or market. As with any retailer, economic conditions, cyclical customer demand and changes in purchasing or distribution can affect the carrying value of inventory. As circumstances warrant, we record the lower of cost or market inventory adjustments. In some instances, these adjustments can have a material effect on the financial results of an annual or interim period. In order to determine such adjustments, we evaluate the age, inventory turns and estimated market value and returnability of merchandise inventory by product category and record an adjustment if estimated market value is below cost.

Rental Asset Depreciation. We have established rental asset depreciation policies that match rental product costs with the related revenues. These policies require that we make significant estimates, based upon our experience, as to the ultimate amount and timing of revenue to be generated from our rental product. We utilize an accelerated method of depreciation because it approximates the pattern of demand for the product, which is higher when the product is initially released by the studios for rental and declines over time. In establishing salvage values for our rental product, we consider the sales prices and sales volume of our previously rented product and other used product.

We currently depreciate the cost of our rental assets on an accelerated basis over six months or nine months, except for rental assets purchased for the initial stock of a new store, which are depreciated on a straight-line basis over 36 months. Rental assets, which include DVDs, Blu-rays and video games, are depreciated to salvage values ranging from $4 to $15. Rental assets purchased for less than established salvage values are not depreciated.

We also review the carrying value of our rental assets to ensure that estimated future cash flows exceed the carrying value. We periodically record adjustments to the carrying value of previously rented product primarily for estimated obsolescence or excess product based upon changes in our original assumptions about future demand and market conditions. If future demand or actual market conditions are less favorable than our original estimates, additional adjustments, including adjustments to useful lives or salvage values, may be required. We continually evaluate the estimates surrounding the useful lives and salvage values used in depreciating our rental assets. Changes to these estimates resulting from changes in consumer demand, changes in customer preferences or the price or availability of retail products may materially impact the carrying value of our rental assets and our rental margins.


The costs of rental product purchased pursuant to revenue-sharing arrangements, which are recorded in rental cost of sales on the consolidated statements of operations, typically include a lower initial product cost than traditional rental purchases with a certain percentage of the net rental revenues shared with studios over an agreed period of time. Any up-front costs exceeding the designated salvage value are amortized on an accelerated basis, and revenue-sharing payments pursuant to the applicable arrangement are expensed as rental cost of sales as the related revenue is earned. Additionally, certain titles have performance guarantees. We analyze titles that are subject to performance guarantees and recognize an estimated expense for under-performing titles throughout the applicable period based upon our analysis of the estimated rental revenue shortfall. We revise these estimates on a monthly basis, based on actual results.

Impairment or Disposal of Long-Lived Assets. We evaluate under-performing stores on a quarterly basis to determine whether projected future cash flows over the remaining lease term are sufficient to recover the carrying value of the fixed asset investment in each individual store. If projected future cash flows are less than the carrying value of the fixed asset investment, an impairment charge is recognized if the estimated fair value is less than the carrying value of such assets. The carrying value of leasehold improvements, in addition to certain other property and equipment, is subject to impairment write-down.

Income Taxes. In determining net income (loss), we make certain estimates and judgments in the calculation of tax expense and the resulting tax liabilities and in the recoverability of deferred tax assets that arise from temporary differences between the tax and financial statement recognition of revenues and expenses. We record deferred tax assets and liabilities for future income tax consequences that are attributable to differences between financial statement carrying amounts of assets and liabilities and their income tax bases. We base the measurement of deferred tax assets and liabilities on enacted tax rates that we expect will apply to taxable earnings in the year when we expect to settle or recover those temporary differences. We recognize the effect on deferred tax assets and liabilities on any change in income tax rates in the period that includes the enactment date. A valuation allowance is established if it is more likely than not that a deferred tax asset will not be realized. In determining the appropriate valuation allowance, we consider all available positive and negative evidence, including our ability to carry back operating losses to prior periods, projected future taxable income, tax planning strategies and the reversal of deferred tax liabilities. We reassess the valuation allowance quarterly, and, if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

The tax benefit from an uncertain tax position is recognized only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than fifty percent likelihood, on a cumulative basis, of being realized upon ultimate settlement. We recognize interest and penalties relating to any uncertain tax positions as a component of income tax expense.

Gift Card Breakage Revenue. We sell gift cards through each of our stores and through our web site www.goHastings.com. The gift cards we sell have no stated expiration dates or fees and are subject to potential escheatment rights in some of the jurisdictions in which we operate. Gift card liabilities are recorded as deferred revenue at the time of sale of such cards, with the costs of designing, printing and distributing the cards recorded as expense as incurred. Revenue from sales of gift cards is recognized when the gift card is redeemed by the customer, or the likelihood of a gift card being redeemed by the customer is remote (gift card breakage). Gift card breakage revenue is recognized as gift cards are redeemed, based upon an analysis of the aging and utilization of gift cards, our determination that the likelihood of future redemption is remote and our determination that such balances are not subject to escheatment laws applicable to our operations.


Results of Operations

The following tables present our statement of operations data, expressed as a
percentage of revenue, and the number of superstores open at the end of the
periods presented herein.



                                                        Three Months Ended
                                                             April 30,
                                                        2014            2013
       Merchandise revenue                                 88.1 %        86.9 %
       Rental revenue                                      11.9          13.0
       Gift card breakage revenue                           0.0           0.1
       Total revenues                                     100.0         100.0
       Merchandise cost of revenue                         69.3          68.0
       Rental cost of revenue                              34.7          34.5
       Total cost of revenues                              65.2          63.5
       Gross profit                                        34.8          36.5
       Selling, general and administrative expenses        37.9          38.3
       Operating loss                                      (3.1 )        (1.8 )
       Other income (expense):
       Interest expense                                    (0.3 )        (0.2 )
       Other, net                                           0.3           0.1
       Loss before income taxes                            (3.1 )        (1.9 )
       Income tax expense (benefit)                         0.1           0.1
       Net loss                                            (3.2 )%       (2.0 )%

Summary of Superstore Activity (1)



                                      Three Months Ended          Year Ended
                                           April 30,              January 31,
                                      2014            2013           2014
         Beginning number of stores      127            137                137
         Openings                          0              0                  0
         Closings                         (1 )           (3 )              (10 )
         Ending number of stores         126            134                127

(1) As of April 30, 2014, we operated three concept stores, consisting of two Sun Adventure Sports and one TRADESMART, which were not included in the summary of superstore activity.

Financial Results for the 1st Quarter of Fiscal Year 2014

Revenues. Total revenues for the first quarter decreased approximately $5.1 million, or 4.7%, to $104.0 million compared to $109.1 million for the first quarter of fiscal 2013. As of April 30, 2014, we operated 8 fewer Hastings superstores, as compared to April 30, 2013. The following is a summary of our revenues results (dollars in thousands):

                                         Three Months Ended April 30,
                                      2014                          2013                 Increase/(Decrease)
                                            Percent                       Percent
                            Revenues        Of Total      Revenues        Of Total       Dollar         Percent
Merchandise Revenue         $  91,586           88.1 %    $  94,800           86.9 %   $   (3,214 )        -3.4 %
Rental Revenue                 12,348           11.9 %       14,213           13.0 %       (1,865 )       -13.1 %
Gift Card Breakage Revenue         23            0.0 %          114            0.1 %         (91)         -79.8 %
Total Revenues              $ 103,957          100.0 %    $ 109,127          100.0 %   $   (5,170 )        -4.6 %


Comparable-store revenues ("Comp")

   Total        0.2 %
   Merchandise  1.6 %
   Rental      -8.8 %

Below is a summary of the Comp results for our major merchandise categories:

                                  Three Months Ended April 30,
                                     2014              2013
                   Trends            25.9%             7.9%
                   Video Games       13.7%            -21.6%
                   Electronics       7.0%              18.4%
                   Movies            0.1%              3.9%
                   Consumables       -4.3%             -5.5%
                   Books             -5.7%             -8.4%
                   Hardback Café     -8.8%             9.1%
                   Music            -14.5%            -13.1%

Trends Comps increased 25.9% for the quarter primarily due to strong sales in action figures, comics, novelty toys, licensed and branded products, and recreational and lifestyle products. Licensed and branded products for which we experienced strong sales during the quarter were Magic the Gathering, Frozen and Doctor Who. The Trends department also includes recreation and lifestyles products whose growth was driven by the addition of hobby products to reset stores as well as growth in the existing categories of skateboards, licensed sports and disc golf. Hobby products continued to show strong growth during the quarter with sales of remote control vehicles and model kits. Video Games Comps increased 13.7% during the quarter due to continued sales of PlayStation 4 and the Xbox One game consoles as well as the release of several high profile games such as Titanfall, Infamous Second Son and South Park. Electronics Comps increased 7.0% for the quarter primarily due to increased sales in musical instruments and instrument accessories, televisions, turntables, speaker systems, tablets, home electronics, and phone accessories. Movies Comps remained relatively flat for the quarter due to a slight decrease in new and previously viewed DVD's partially offset by an increase in used DVD's. Sales of promotional product were not as strong as expected but we continue to have strong sales in new movies from new releases, Blu-rays and boxed sets. Consumables Comps decreased 4.3% for the quarter primarily due to lower sales of bottled drinks and assorted snacks. Books Comps decreased 5.7% for the quarter due to a decrease in paperback, bargain books and magazines, partially offset by sales of the Divergent trilogy. Hardback Café Comps decreased 8.8% for the quarter primarily due to the closing of thirteen Hardback Cafés which operated in comp stores. Music Comps decreased 14.5% for the quarter primarily due to a significant reduction in retail space in the 95 stores that were reset, as of April 30, 2014, as well as the increasing popularity of digital delivery.

Rental Comps decreased 8.8% for the first quarter, primarily resulting from fewer rentals of traditional DVDs and video games, partially offset by an increase in rentals of Blu-ray movies. Rental Movie Comps decreased 7.1% and Rental Video Game Comps decreased 25.6% for the quarter primarily as sales were negatively impacted by competition from rental kiosks and subscription-based rental services.

Gross Profit - Merchandise. For the first quarter, total merchandise gross profit dollars decreased approximately $2.3 million, or 7.6%, to $28.1 million from $30.4 million for the same period in the prior year, primarily due to a decrease in revenue attributed to operating eight fewer superstores this quarter compared to the same quarter in the prior year. As a percentage of total merchandise revenue, merchandise gross profit decreased to 30.7% for the quarter compared to 32.0% for the same quarter in the prior year, primarily due to a shift in mix of revenues by category and higher markdown expenses and freight expenses, partially offset by lower expense to return products and lower shrinkage.

Gross Profit - Rental. For the first quarter, total rental gross profit dollars decreased approximately $1.2 million, or 12.9%, to $8.1 million from $9.3 million for the same period in the prior year, primarily due to a decrease in revenue partially attributed to operating fewer superstores this quarter compared to the same quarter in the prior year. As a percentage of total rental revenue, rental gross profit slightly decreased to 65.3% for the quarter compared to 65.5% for the same quarter in the prior year.

Selling, General and Administrative Expenses ("SG&A"). As a percentage of total revenue, SG&A decreased to 37.9% for the first quarter compared to 38.3% for the same quarter in the prior year. SG&A decreased approximately $2.3 million during the quarter, or 5.5%, to $39.4 million compared to $41.7 million for the same quarter last year. The decrease results primarily from a $1.4 million reduction in corporate salary expense due to the restructuring that took place in the first quarter of fiscal 2013, a decrease of $0.8 million in store labor expense, $0.5 million reduction in depreciation expense, a decrease in store advertising expense of $0.2 million,


a decrease of $0.2 million in store occupancy expense and a decrease of $0.1 million in store supplies. The decrease in store expenses were primarily the result of operating fewer superstores this quarter compared to the same period in the prior year. The reductions were partially offset by an increase of $0.6 million in legal and other expenses associated with the proposed merger and an increase in senior retirement plan expense of $0.3 million related to the payout of the Supplemental Executive Retirement Plan ("SERP"). The increase in expense related to the SERP is offset by an increase in other income resulting from an Other Comprehensive Income (OCI) reclassification adjustment from the realization of a gain upon the distribution of the investments for the SERP.

Interest Expense. For both the first quarter of fiscal 2014 and fiscal 2013, interest expense was approximately $0.3 million. Interest rates for both periods averaged 2.5%.

Income Tax Expense. As the Company has a net operating loss and a net deferred tax asset, which has been offset by a full valuation allowance at April 30, 2014, there is no tax liability, with the exception of Texas state income tax; therefore, the effective tax rate for the first quarter of fiscal 2014 is (1.6%). The valuation allowance is approximately $15.6 million as of April 30, 2014. We reassess the need for a valuation allowance quarterly, and if future evidence allows for a partial or full release of the valuation allowance, a tax benefit will be recorded accordingly.

Store Activity

Since April 21, 2014, when we last reported store activity, we have not closed any of our stores or opened any new stores.

Liquidity and Capital Resources

We generate cash from operations from the sale of merchandise and the rental of products, most of which is received in cash and cash equivalents. Our primary sources of working capital are cash flow from operating activities including trade credit from vendors and borrowings under our revolving credit facility, with the most significant source during the first three months of fiscal 2014 being cash flows from borrowings under our revolving credit facility. Other than our principal capital requirements arising from the purchasing, warehousing and merchandising of inventory and rental products, opening new stores and expanding or resetting existing stores and updating existing and implementing new information systems technology, we have no anticipated material capital commitments. We believe the Company will have adequate resources to fund its cash needs for the next twelve months and beyond, including its capital spending, its seasonal increase in merchandise inventory and other operating cash requirements and commitments.

At April 30, 2014, total outstanding debt was approximately $51.3 million. We project our outstanding debt level will be in the range of $56.0 million to $60.0 million by the end of fiscal 2014. At April 30, 2014, we had approximately $46.3 million in excess availability, after the $10 million availability reserve, under the Credit Agreement (as defined herein).

The Merger Agreement places certain limitations on our ability to, among other things, repurchase shares, declare dividends and make capital expenditures in excess of certain thresholds. In addition, the Merger Agreement places certain limitations on the amount of additional debt we can assume outside of our Credit Agreement.

Consolidated Cash Flows

Operating Activities. Net cash provided by operating activities totaled approximately $5.2 million for the three months ended April 30, 2014, compared to cash provided by operating activities of $7.2 million for the three months ended April 30, 2013. Net loss for the current period was approximately $3.2 . . .

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